The Global Rule of Three: Competing with Conscious Strategy

By Jagdish Sheth, Can Uslay and Raj Sisodia

**Finalist for the 2022 Leonard L. Berry Marketing Book Award from the American Marketing Association, which recognizes the top marketing books annually**

In our increasingly digital, mobile, and global world, the existing theories of business and economics have lost much of their appeal with the phenomenal rise of Chindia, the reality of Brexit, the turmoil caused by the Covid-19 pandemic, and the seismic shifting of the global center of gravity from west to east. In the area of innovation, the traditional thinking that a developed country, often the US, will come up with the next major innovation, launch at home first, and then take it to other markets does not ring true anymore. Similarly, the world where conglomerates go bargain-hunting for acquisitions in emerging markets has been turned upside-down.

This book reveals and illustrates the Global Rule of Three phenomenon, which stipulates that in competitive markets only three companies (which the authors call "generalists") can dominate the market. All other players in the market are specialists. Further, whereas the financial performance of generalists improves as market share increases, specialist companies see a decrease in financial performance as their market share increases, as the latter are margin-driven companies. This theory powerfully captures the evolution of global markets and what executives must do to succeed. It is based on empirical analyses of hundreds of markets and industries in the US and globally. Competitive markets evolve in a predictable fashion across industries and geographies, where every industry goes through a similar lifecycle from beginning to end (or revitalization). From local to regional to national markets, the last stop in the evolution of markets is going global. The pattern is so consistent that it represents a distinct and natural market structure at every level.  The authors offer strategies that generalists and specialist should follow to stay competitive as well as twelve expansion strategies for global companies from emerging markets.

 

This book chronicles this global evolution and provides impactfulmanagerial implications for executives and students of marketing and corporate strategy alike.
 

• Language: English
• Publisher: Palgrave Macmillan
• Release date: Dec 10, 2020
• ISBN: 9783030574734

Jagdish Sheth

Jagdish Sheth is the Charles H. Kellstadt Professor of Marketing at the Goizueta Business School, Emory University, and the founder of the Center of Relationship Marketing. He has served as an advisor and consultant to AT&T, Lucent, Motorola, and Young and Rubicam, and contributes regularly to The Wall Street Journal and other publications. He lives in Atlanta, Georgia.

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© The Author(s) 2020

J. Sheth et al.The Global Rule of Threehttps://doi.org/10.1007/978-3-030-57473-4_1

1. What Is the Rule of Three?

Jagdish Sheth¹  , Can Uslay²   and Raj Sisodia³  

(1)

Emory University, Goizueta Business School, Atlanta, GA, USA

(2)

Rutgers University, Rutgers Business School, Newark and New Bruncswick, NJ, USA

(3)

Babson College, Olin Graduate School of Business, Wellesley, MA, USA

Jagdish Sheth (Corresponding author)

Email: [e-mail]

Can Uslay

Email: [e-mail]

Raj Sisodia

Email: [e-mail]

Consider the history of the U.S. telecom market. Twenty-two Baby-Bells (operating telephone companies) were divested after the breakup of AT&T by the U.S. government in 1982. Baby-Bells initially organized into seven players by region. Subsequently, roughly 240 firms engaged in reselling long-distance calls, and AT&T’s market share collapsed from 90% to under 40%. After a period of shakeout and mergers , there were three survivors —AT&T, MCI, andSprint . Interestingly, MCI was not only the largest competitor but also the largest customer of AT&T. Today , in wireless communications , three major players are also emerging with #1 AT&T (which was ironically acquired in 2005 by one of the former Baby -Bells, SBC a.k.a. Southwestern Bell), #2 T-Mobile-Sprint, and #3 Verizon . Similarly, the Pay TV market also went through the same journey and three players dominate the market—Comcast with 24% market share , followed by DirecTV with 21%, and Dish Network with 15% share.¹

Akron, Ohio came to fame as the Rubber City after Benjamin Franklin Goodrich moved his small rubber business from Jamestown, N.Y., to Akron in 1870. Iconic brands such as Goodyear (1898), Firestone (1900), Cooper Tire (1914), and General Tire and Rubber (1915) were all founded in Akron where at one time almost two-thirds of U.S. tire production was concentrated.² Three large players (Goodyear , Firestone , and BF Goodrich ) emerged historically, whereas others such as Cooper tire remained viable specialists . Decades later, there are still three large players and Goodyear is still the U.S. market leader, yet it is also the sole remaining U.S.-owned tire manufacturer. Michelin (of France which bought BF Goodrich ), and Bridgestone (of Japan which bought Firestone ) round up the top three, while specialist Cooper has been bought by Apollo from India .

Sometimes convergence to the big three can happen organically and relatively quickly. The battle to deliver food to homes is only a few years old. However, 55% of Americans aged 18–24 already use online restaurant delivery services.³ GrubHub started out as an online restaurant order platform in 2011 but pivoted after five years and began to deliver restaurant food in 2016. Seeing proof -of-concept, Uber became a delivery player with Uber Eats in 2017 and DoorDash joined in 2018. The players in the restaurant delivery market are experimenting and thriving: DoorDash rents space in San Francisco to enable third party chefs who only serve their cuisine via the delivery apps, and Uber states 17% of all of its rides hailed globally is for deliveries.⁴ As of May 2020, DoorDash had the lead with 45% share of the market, and GrubHub (soon to be acquired by Just Eat Takeaway for $7.3 billion) with its 23% share barely edged over Uber Eats’ 22%.⁵ Uber Eats is poised to become #2 soon, however. In July 2020, it announced it is acquiring Postmates (and its 8% market share ) for $2.65 billion.⁶

Duopoly broken, revolution in action: Founded in 1901, Gillette (acquired by P&G for $57 billion in 2005)⁷ ruled the razor market for over a century and had more than 70% market share in the U.S. earlier in the last decade. Today, it is down to about 50% with Schick commanding another 15% and both are bleeding shares fast.⁸ Dollar Shave Club and Harry’s came in with their direct-to-consumer subscription models in 2012 and 2013 respectively and disrupted the market. The market may be mature; however, Dollar Shave Club (acquired by Unilever for $1 billion in 2016)⁹ captured more than half of online sales within five years of inception and currently plans to launch a deodorant line.¹⁰ Meanwhile , Edgewell Personal Care (parent company of Schick and Wilkinson razor brands ) has acquired Harry’s for $1.37 billion.¹¹ We may finally see the emergence of the rule of three in this space.

Race to the cloud : AWS (Amazon Web Services ), Azure (Microsoft ), and Google Cloud are quickly emerging as the three leaders in cloud services . By 2020, AWS is predicted to have 52% market share, followed by 21% for Azure , and 18% for Google in the U.S.¹² Other players such as IBM , Oracle , and Salesforce will likely persist as specialists .

Over the past several years, the world economy, principally in the developed free-market economies of North America and Europe, has witnessed a unique combination of economic phenomena: mergers as well as demergers (i.e., spin-offs of non-core businesses) at record levels with no signs of slowing down. Since 2012, M&A activity has increased dramatically in both number of deals and size of transaction, with the yearly value of global M&A deals tracking above $4.5 trillion for the past four years.¹³ Just weeks before the U.S. presidential elections, October 2016 set a monthly record for U.S. merger activity aided by the biggest acquisition of the year (AT&T’s acquisition of Time Warner for $85.4 billion), and one that created the world’s largest tobacco company (British Tobacco’s acquisition of Reynolds American for $47 billion).¹⁴

Overall, the deals announced in October 2016 alone amounted to almost a quarter of trillion dollars ($248.9 billion).¹⁵ The number of billion-dollar transactions was up by 25% and the number of megadeals exceeding $25 billion in value increased by more than 100% in 2018!¹⁶ According to a 2019 mergers and acquisitions (M&A) trends report by Deloitte, 76% of M&A executives, and 87% of M&A leaders at U.S. private equity firms expect to close more deals over the next year (up from 69% and 76% the year before respectively).¹⁷ Furthermore, they expect the sizes of these transactions to be more significant. Meanwhile, more than 80% of the executives also stated they intended to divest units or portfolio companies in 2019, up from 70% the year before.

Consequently, the landscape of just about every major industry has been changing in a significant way, a process that has been further accelerated by the COVID-19 pandemic. Industries as varied as wireless communications (T-Mobile-Sprint), aluminum (M&A deals in metals surged 90% in 2018),¹⁸ banking (SunTrust and BBT merger worth $66 billion),¹⁹ pharmaceuticals (Bristol-Myers Squibb bid for Celgene),²⁰ and airlines (acquisition of Virgin America by Alaska Air) are in the midst of rationalization and consolidation, moving inexorably toward what we call the Rule of Three.²¹ And for the oil industry, [i]n five days in late October [2018] alone, corporate consolidation saw a bona fide frenzy with Denbury buying Penn Virginia for $1.7 billion, Chesapeake bidding $4 billion for WildHorse, and EnCana acquiring Newfield for $4.2 billion.²² Indeed, the great recession of 2007, the threat of Brexit, the trade wars of the Trump administration, and COVID-19 have slowed but not halted this fundamental evolution, nor has it altered its basic direction.

The Wall Street Journal argued that the pace of mergers demonstrates how strong the urge is for [firms] to combine at a time of persistently sluggish economicgrowth.²³ However, this argument fails to explain why corporate spin-off activities are keeping brisk pace with record levels of acquisitions and why the two activities go in hand.²⁴ Why, for example, did Dell’s announcement that it may spin-off VMwarepropel its stock price up by 14%?²⁵ We argue that there is a more powerful explanation that explains the M&A and spin-off surge: the Rule of Three.

What Is the Rule of Three?

Just as living organisms have a reasonably standard pattern of growth and development, so do competitive markets, and our research involving hundreds of industries has revealed that markets evolve in a highly predictable fashion, governed by the Rule of Three.

Through competitive market forces, markets that are largely free of regulatory constraints and major entry barriers (such as very restrictive patent rights or government-controlled capacity licenses) eventually get organized into two kinds of competitors: full-line generalists and product/market specialists. Full-line generalists compete across a range of products and markets and are volume-driven players for whom financial performance improves with gains in market share. Specialists tend to be margin-driven players, who actually suffer deterioration in financial performance by increasing their share of the broad market beyond a certain level. Contrary to traditional economic theory, then, evolved markets tend to be simultaneously oligopolistic as well as monopolistic.

Figure 1.1 plots financial performance and market share, illustrating the central paradigm of the Rule of Three: in competitive, mature markets, there is only room for three full-line generalists , along with several (in some markets, numerous) product or market specialists. Together, the three inner circle competitors typically control, in varying proportions, between 70% and 90% of the market. To be viable as volume-driven players, companies must have a critical-mass market share of at least 10%. As the illustration shows, the financial performance of full-line generalists gradually improves with greater market share, while the performance of specialists drops off rapidly as their market share increases.

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Fig. 1.1

The Rule of Three. (Source: Adapted from Competitive Positioning: The Rule of Three presentation by Jagdish N. Sheth, 2017)

There is a discontinuity in the middle; mid-sized companies almost always exhibit the worst financial performance of all. We label this middle position the ditch, the competitive pothole in the market (generally between 5% and 10% market share), where competitive position (and, thus, financial performance) is the weakest. The rule of competitive market physics is straightforward—those closest to the ditch are the ones most likely to fall into it. Therefore, the most desirable competitive positions are those furthest away from the middle. Firms on either side of the ditch—especially those close to it—need to develop strategies to distance themselves. If a firm in a mature industry finds itself in the ditch, it must carefully consider its options and formulate an explicit strategy to move to either the right or the left.

The Shopping Mall Analogy

The Rule of Three applies (and renews itself) at every stage of a market’s geographic evolution—from local to regional, regional to national, and national to global. A useful analogy to mature competitive markets is a shopping mall. Mature markets are anchored by a few full-line generalists, which are akin to the full-service anchor department stores (such as Macy’s and JC Penney) in a mall. In addition, a number of other players are positioned as either product specialists or market specialists. In a mall, a store such as Foot Locker is clearly a product specialist, whereas Zara is more of a market specialist. While Foot locker sells primarily athletic shoes, Zara has a well-defined target market—young, price- and trend-conscious urban women (and men)—and caters to a wide range of their fashion needs.²⁶

Shopping malls come in different sizes and architectures but are invariably characterized by (typically three) anchor stores which are full-line volume-driven generalists.²⁷ These generalists can sell anything as long as it generates profits through turns or volume. However, in between these generalists, there are numerous specialty retailers which are predominantly margin-driven. In the same shopping mall, monopolistic competition is represented by the smaller vendors (specialty retailers), whereas the oligopolistic competition takes place between the anchor stores competing on volume. Examples of such generalists are Target, JC Penney, Macy’s, Nordstrom, Lord & Taylor, Sears, and (and in the old days) Montgomery Ward. The anchor stores attract traffic and co-exist with specialty retailers in malls across the world today. Examples of specialty retailers include Foot Locker, GameStop, Kay Jewelers (product specialists); and Benetton, Coach, and Five Below (market specialists). Finally, there are usually a few restaurants and a food court in the center.

For example, whereas Sears (a full-line generalist ) used to carry shoes for men, women, and children; and dress shoes, casual, and athletic shoes (3 × 3 segments), Foot Locker (product specialist) primarily focused on athletic shoes for men. They have subsequently expanded into athletic shoes for women and kids with Lady Foot Locker and Kids Foot Locker respectively. Foot Locker does not offer a one-stop-shop to a family as a generalist does. Meanwhile, it tends to command a 20% premium over the generalist for the same stock keeping units (SKUs).²⁸

In exclusive and super niche markets, the high price itself may actually represent prestige and value as in expensive perfumes, handbags, and gowns further reinforcing the margins of these retailers. Hence, the shopping mall analogy is very fitting to explain the margin versus volume dichotomy and the corresponding dynamics for other industries. The organization of a typical shopping mall is depicted in Fig. 1.2.

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Fig. 1.2

The shopping mall analogy. (Source: Adapted from Competitive Positioning: The Rule of Three presentation by Jagdish N. Sheth, 2017)

There is usually considerable overlap between the offerings of specialists and generalists. Yet the specialists enjoy significant price premiums over generalists. So why would customers opt to pay 20% more for the same shoes about 100 yards apart in the same mall? The answer is that a specialist such as Foot Locker is able to add value in ways a generalist cannot. The value difference may not be in the particular shoe/product which is identical to what Sears might sell, but rather in the service and selection of offerings. Whereas a Sears’ employee may typically lack specific knowledge of the product and is more of an order taker, Foot Locker employees are required to be active in at least two sports and they tend to be young athletes with vast personal experience and knowledge of the brands and shoes. Naturally, they are better equipped to educate consumers and engage in consultative selling. Foot Locker also offers a broader selection of shoe sizes and deeper variety of offerings for specific sports. Moreover, their superior margins are not only a consequence of their price premiums but also of their lower procurement cost. Foot Locker is a bigger customer for Nike, Adidas, and Under Armour athletic shoes than Sears, since it specializes in the athletic shoe category whereas Sears’ procurement is divided across multiple shoe segments sourced from different suppliers. This helps explain why Sears is struggling to survive today (it is now part of an entity called TransformCo, which also owns Kmart).

Of course, you may be wondering whether the shopping mall analogy is still relevant when a third of the 1200 or so enclosed malls in the U.S. are either dead or dying.²⁹ As a matter of fact, this very phenomenon can also be explained by the Rule of Three.

While retailers around the world (including the very generalists such as Sears, JC Penney, and Macy’s we have referenced as well as specialists such as Victoria’s Secret) are struggling, consumers around the world have not decreased their spending. If anything, global consumption has exploded. Consumers have simply been moving their purchases online, hence the phenomenal growth of one-stop e-tailers such as Amazon and Alibaba. E-tailers have been effectively stealing share from the malls and their tenants which put many retail giants such as Sears on the chopping block as they get deeper and deeper into the ditch. Amazon alone has effectively become a phantom generalist for an increasing majority of U.S. households.³⁰ And with the Whole Foods acquisition, the phantom now has a body for itself leaving other retailers in a frail state. Thus, shopping malls will have to reinvent themselves as showroom, recreation, or service malls. Attempts are underway, and whether or not a family experience can revive our favorite malls remains to be seen.³¹ Meanwhile, the Rule of Three in retailing has now become omni-channel where full-line generalists strive to establish leadership in both online and physical stores. Walmart, Amazon, and Target co-exist with numerous specialty retailers such as Zara, Motherhood Maternity, Tom’s Shoes, Lululemon, Tiffany, and others.

Box 1.1 The Case of a Successful Specialist: Zara³²

Founded in Spain in 1974, and ranked the 25th most valuable brand in the world by Interbrand in 2018 (with brand equity value in excess of $17.7 billion),³³ Zara has redefined specialty retail for decades. Keenly focused on changing customer taste and preferences, Zara offers more products (styles and choices) than most competitors do, and yet it can be considered the consummate market specialist. Thanks to its short and frequent production runs, while most competitors are happy to get to market in a few months, Zara can modify existing merchandise in as little as two weeks, and ship brand-new designs in another two to four. Furthermore, short production runs provide inherent flexibility so that the company does not have to place big bets on next season’s fashion trends. Limited batch production also ensures lean inventory, and creates a sense of urgency with the customers since any given item could sell out immediately.

Zara has created a loyal following among its target demographic of 24–35-year-old women, who visit Zara stores 17 times a year as opposed to three times for competing stores. It sells 85% of its merchandise at full price (vs. 60% industry average) and carries only 10% unsold inventory (vs. industry averages ranging from 17% to 20%). Such customer loyalty ultimately enables Zara to enjoy 12 inventory turns per year whereas most competitors merely average 3–4 turns.

Rather than discounting or spending heavily on advertising like most of its competitors, Zara invests to maintain a lean and agile supply chain which enables 48-hour deliveries to most markets. This, in turn, enables it to respond to consumer preferences in each market very quickly, setting Zara apart from its generalist as well as direct competitors.

How Competitive Markets Evolve

By observing how numerous markets have evolved, we have identified the primary drivers of change and a pattern of evolution. In the auto industry’s late nineteenth-century infancy, for example, some 500 manufacturers were building cars in the U.S. alone, none on a truly national scale. It took the 1909 launch of the Model T and Henry Ford’s innovations in mass production to establish a standard and initiate the process of industry consolidation. By 1917, the number of manufacturers dwindled to just 23; by the 1940s, the market had consolidated further into three full-line players (GM , Ford, and Chrysler) and several niche players such as American Motors (which failed in its attempts at becoming a generalist and was acquired by Renault and then by Chrysler), Checker, and Studebaker. Eventually, the Rule of Three prevailed, with GM, Ford, and Chrysler dominating the U.S. market.

Two driving forces shape markets: efficiency and growth (see Fig. 1.3). Growth comes primarily from creating customer demand while efficiency is a function of optimized operations. In cyclical pursuit of these objectives, markets get organized and reorganized over time.

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Fig. 1.3

How markets evolve. (Source: Adapted from The Global Rule of Three presentation by Jagdish N. Sheth, 2017)

Although early entrants can specialize in different ways, almost all tend to be product specialists. Young markets tend to have few technical standards, low barriers to entry and exit, and a decidedly local geographic focus. Newly created markets are typified by rapid growth and the presence of numerous competitors jockeying for position. This quickly leads to excess capacity as the market attracts more entrants than it can support.

Even though viable start-up markets grow rapidly in pursuit of scale economies, they tend to be highly inefficient; firms within the industry lack economies of scale, operational experience, and tools to automate production and distribution tasks. They tend to be vertically integrated, producing many of their own inputs, since a well-defined supply function has yet to emerge in the fledgling industry. Consequently, during the growth phase, the drivers of market evolution are geared to creating efficiency by enhancing scale economies and lowering costs. There are four key processes by which this happens:

Creation of Standards: Market processes often result in the creation of a de facto standard. The standard could be for products (as with Windows in personal computing or Google for search engines) or processes (as with the assembly-line manufacturing process pioneered for the Model T or six-sigma/lean manufacturing).

Shared Infrastructure: The market might also create efficiency through the development of a shared infrastructure. Infrastructure costs are generally too high to be loaded on to the transactions generated by any one company. Consequently, the government may take the lead in creating or organizing the infrastructure or one company could develop an infrastructure for its internal needs and then make it widely available. For example, banks benefit greatly from shared infrastructures for check clearing, credit card transactions, and automated teller networks. Airlines require shared infrastructures for reservations, air traffic control, and ground services.

Governmental Intervention: If it sees that an important market is failing to achieve efficiency on its own, the government may intervene. In the U.S., this occurred in the telephone and railroad markets when too many companies started laying cable and setting up tracks. Each one wanted monopoly power and so made themselves incompatible with the others. The government intervened and created standards and sanctioned natural monopolies to generate efficiency.

Consolidation: Finally, market processes create efficiency in a highly fragmented market through the consolidation of small, inefficient players into larger ones.

Eventually, market growth begins to slow down and the drive for efficiency transforms an unorganized market with many players into an organized one with far fewer players. After a start-up industry achieves a high level of efficiency through the realization of scale economies, the focus shifts toward the achievement of scope economies. This typically occurs through market expansion (from local to global) and/or product line expansion (from specialty to full line).

When a market is in its infancy, all the players are on the left side of Fig. 1.1. Then, one player makes the turn and becomes a broad-based supplier, through acquisitions (as General Motors (GM) did in the automobile industry), the creation of a de facto standard, and so on. It is at this point that the market’s natural evolution toward the Rule of Three manifests itself, allowing room for two additional players to evolve into full-line generalists.

Over time, as growth slows and the industry becomes mature, the forces of technological change, shifting regulations, market shifts and changing investor expectations may give rise to a revolution or revitalization of the industry. Through such periodic upheavals, the potential exists for the competitive landscape to be redrawn in a substantially different way. Savvy incumbents are able to sustain or improve on their leadership positions, while aggressive newcomers replace others.

Some industries eventually enter a phase wherein growth slows dramatically and industry efficiency declines. Survivors in such industry focus on improving financial performance through descaling processes such as capacity reduction, the outsourcing of non-core functions, the breakup of vertical integration and/or exiting the industry and focusing resources elsewhere. Figure 1.4 summarizes this process.

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Fig. 1.4

Stages of industry evolution over time. (Source: Adapted from Competitive Positioning: The Rule of Three presentation by Jagdish N. Sheth, 2017)

Common Elements in Market Evolution

By analyzing the evolution of hundreds of competitive markets, we have arrived at the following generalizations:

A typical competitive market starts out in an unorganized way, with only small players serving it. As markets expand, they get organized through a process of consolidation and standardization. This process eventually results in the emergence of a small handful of full-line generalists surrounded by a number of product specialists and market specialists. Contrary to the prevailing wisdom that they only occur when an industry matures or shrinks, such shakeouts often take place during market expansion (e.g., wireless telecom industry).

With uncanny regularity, the number of full-line generalists that survive this transition is three.³⁴ In the typical market, the market shares of the three eventually hover around 40%, 20%, and 10%, respectively.³⁵ Together, they generally serve between 70% and 90% of the market, with the balance going to product/market specialists.³⁶ We have found that the extent of market share concentration among the big three depends on the extent to which fixed costs dominate the cost structure.

The Rule of Three applies (and renews itself) at every stage of a market’s geographic evolution—from local to regional, regional to national, and national to global.

The financial performance of the three large players improves with increased market share—up to a point (typically 40%). Beyond that point, diminishing returns and diseconomies of scale set in, along with the potential for regulatory problems related to heightened anti-monopoly scrutiny.³⁷ Therefore, divestiture and international expansion should become priorities for market leaders with more than 40% share.

If the top player commands 70% or more of the market (usually because of proprietary technology or strong patent rights), there is often no room for even a second full-line generalist . When IBM dominated the mainframe business many years ago, all of its competitors had to become niche players to survive. When the market leader has a share between 50% and 70%, there is often only room for two full-line generalists. Similarly, if the market leader enjoys considerably less than 40%, there may (temporarily) be room for a fourth generalist player.

A market share of 10% is the minimum level necessary for a player to be viable as a full-line generalist. Companies that dip below this level are not viable as full-line players, and must make the transition to specialist status to survive; alternatively, they must consider a merger with another company to regain a market share above 10%. In the U.S. airline industry, US Airways, Northwest, and America West all succumbed to the ditch; and each eventually had to merge with one of the Big Three (American, United, and Delta) in order to survive. Even earlier ditch players, such as Eastern, Braniff, Pan Am, and TWA, have already perished.

In a market suffering through a downturn in growth, the fight for market share between #1 and 2 often sends the #3 company into the ditch. For example, this happened in soft drinks (RC Cola wound up in the ditch), beer industry (Schlitz), aircraft manufacturing (Lockheed first, then McDonnell Douglas), and automobiles (previous battles between GM and Ford drove Chrysler perilously close to extinction several times).

Nevertheless, in the long run, a new #3 full-line player usually emerges. For example, in the U.S. soft drink market, Coca-Cola and Pepsi may have top-of-mind share, but do not count out Keurig Dr. Pepper, which is a product of vigorous M&A activity. Even prior to the 2018 acquisition by Keurig, Dr. Pepper Snapple was viable and comfortably #3 with an 18% share against 43% for Coca-Cola, and 26% for PepsiCo respectively.³⁸

The number one company is usually the least innovative, though it may have the largest R&D budget. Such companies tend to adopt a fast follower strategic posture when it comes to innovation.

The number three company is usually the most innovative. However, its innovations are usually stolen by the number one company unless it can protect them. Such protection becomes more difficult to attain over time.

The extent to which the third-ranked player enjoys a comfortable or precarious existence depends on how far away that player is from the ditch.

The performance of specialist companies deteriorates as they grow market share within the overall market (through undifferentiated offerings), but improves as they grow their share of a specialty niche (with ever-more differentiated offerings).

Reckless growth can rapidly lead specialists into the ditch. The airline People Express is a classic example; after a few years of heady growth, the Newark (NJ)-based carrier flamed out as it sought to add flights across the continent and to Europe.³⁹ More recently, Virgin Atlantic also got into trouble as its market share got closer to 5%.⁴⁰

Specialists can make the transition to successful full-line generalists only if there are two or fewer incumbent generalists in the market.

Alternatively, specialists serving a niche that has gone mainstream can sell out to full-line generalists , as Mennon, Maybelline, and Gatorade have done.

Successful product or market specialists typically face only one direct competitor in their chosen specialty. Uber and Lyft can be considered as examples of this, as well as many branded versus generic drugs.

If they face excessive competition in their niche, specialists can move up to become supernichers. For example, some cruise lines have made this transition, as have many boutique practices. Similarly, after its foray into affordable luxury sports car (with Porsche Boxster) depreciated its margins, Porsche also decided to go up-market.

Successful superniche players (that specialize by product and market) are, in essence, monopolists in their niches, commanding 80–90% market share.

Companies in the ditch exhibit the worst financial performance and have a very difficult time surviving.

Ditch dwellers can emerge as big players by merging with one another, but only if there is no viable third-ranked player to block them. General Motors achieved this in the early years of the automobile industry.

A better strategy for ditch companies may be to seek a merger with a successful full-line generalist . The ditch can be a very attractive source of bargains for full-line generalists looking to rapidly boost market share.

Ditch dwellers can emerge as specialists only if they are able to identify a defensible niche in which they have a sustainable competitive advantage through unique resource endowments. Woolworth department stores redefined itself as a specialty retail chain, and PC-maker IBM has sustained itself as a service provider.

The evidence in support of these generalizations is strong and consistent. There is a powerful logic driving market evolution in this direction. The Rule of Three draws on fundamental truths about consumer psychology (e.g., the evoked set of brands typically considered by most consumers consists of three alternatives), competitive dynamics, and the balance of power (see Box 1.2).

Box